McGladrey study: Optimism is local, concern is global

While manufacturing continues to grow in the U.S, concerns remain about the global economy and how regulations might impact or hamper the industry's growth

07/23/2013

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The 2013 McGladrey Manufacturing & Distribution monitor reflects one of the paradoxes of U.S. manufacturing. A majority of the more than 1,000 executives polled in the study said their sales increased in 2012 at a solid pace, both in the U.S. and globally. Even with that healthy report, they expressed concern over economic and regulatory barriers that might either impinge their current growth or restrain their future growth.

Plant Engineering discussed the 2013 report with Karen L. Kurek, a partner at McGladrey LLP and the firm’s national industrial products practice leader.

Plant Engineering: One of the most interesting aspects of the study is that manufacturers are more optimistic about their own business than about the national or world economy as a whole. What is driving this optimism?

Kurek: Over the years, we have found that executives are usually optimistic regarding factors under their control, such as their own companies and even extending to their perspectives of their industries, as compared to those things outside of their influence, such as the domestic and global economies. Thriving companies, not surprisingly, are more optimistic than those that are declining.

This positive outlook may also be a factor of the industry sector in which these executives work. Some 40% of food and beverage companies, for example, are thriving, due in part to a growing consumer confidence and more discretionary spending being directed towards dining. The biotech, life sciences, and medical equipment and supplies sector also has been performing well; 38% of those companies in our survey are thriving. The building materials sector has seen an increase in its percentage of thriving companies, following the upward trajectory of new homes sales and construction.

However, some felt that the anticipated economic bounce-back was not as robust as they had hoped; this disappointment may have been the result of wishful thinking rather than in-depth analysis. Whatever the reason, the current economic situation makes it difficult to sustain any optimism they may be feeling about business conditions.

PE: The issues of federal regulation on manufacturing seem to be a serious concern for manufacturers, more than economic or skills gap issues. How much of that is perception, and how much are regulations actually harming the manufacturing economy?

Kurek: While challenges in skills shortages as well as material and component price increases are recognized as impediments to growth, government policies—and the anticipation of their impact—weigh heavily on the minds of many industry executives. This displacement of traditional concerns, such as market conditions and materials pricing, as top threats represents a major shift for the industry. Although executives remain concerned about those issues, many now see regulation and government policy as the greatest threats to future growth in this post-recession environment.

In any case, perception is reality: These executives are acting according to what they feel are factors that are having a negative impact on growth now or will have an impact at some point in the future. Some of their concerns are in anticipation of an inevitable reduction or flattening of federal spending as well as the costs associated with the continued implementation of the Affordable Care Act in 2014. Additionally, executives at small businesses—those with revenues of less than $50 million—are expecting an increase in the personal tax rate for the highest-earning bracket to negatively affect their businesses.

Corporate tax codes are a particular concern for those companies that operate as S corporations or partnerships, where business income is taxed at the individual income rate. Such a rise in taxes on a personal level or for investment income lowers profits that might otherwise be used for hiring or big-ticket capital improvements.

Several participants are also concerned about the uncertainty of how government regulations are implemented. For example, a government regulator in one sector of the country may interpret EPA compliance regulations one way, and the same set of regulations may be interpreted differently by a regulator in another geographic sector of the country. This uncertainty makes it difficult for executives to plan for growth and business expansion.

PE: Manufacturing was credited with leading us out of the Great Recession. Still, growth in the sector remains constrained. Are we going to be satisfied with a steady 2%-3% growth over a long period, or is there room for more robust growth in this sector?

Kurek: Certainly there is room for growth and, as I mentioned earlier, some industry segments are experiencing tremendous growth. Yet in 2013, most businesses (61%) report that they are holding steady and the percentage of thriving businesses has fallen to 32%, down from 39% in 2012.

That said, it has become clear to us that ranking a company’s business condition is as much a qualitative assessment as it is quantitative. To say a company is thriving, for example, may mean different things to different people. In focus group interviews that we conducted across the country, some industry executives defined thriving as growing faster than the industry; others described it as double-digit growth; still others defined it as being able to turn business away.

However, thriving as a business in the traditional sense—that is, as measured by company revenue, domestic and international sales, and other measurable factors—could remain out of reach as long as concerns regarding economic conditions, regulatory hurdles, and other potential threats to prosperity continue.

PE: Besides the issues mentioned above, what are the other constraints to manufacturing growth?

Kurek: A growing majority of executives anticipate increases across all major cost categories in the next 12 months, which will certainly have an impact on growth and investment. Employee costs for wages, health care, and other benefits are all expected to rise, with health care expected to have an average increase of 10%.

Internal challenges, such as skills gaps, disruptions in the supply chain, machine downtime, and inadequate information technology have led to decreased productivity at some companies.

PE: By whatever term you like to use (we called it right-shoring), manufacturing jobs are migrating back to the U.S. At the same time, foreign direct investment from global manufacturers also is increasing. What do manufacturers see as the keys to this growth, and what can we do to sustain it?

Kurek: Just over half of all respondents to our survey stated that it is important to be in physically close proximity to their customers; this is even more pronounced for distributors. In addition, many manufacturers believe in the importance of having their engineers and product developers close to their manufacturing facilities. We’ve seen this in the automotive sector for years.

Even with the ability to communicate instantaneously around the globe, there are advantages—speed, agility, cost efficiencies, and improved communications—to having developers close to the production process.

Executives have described for us numerous reasons for onshoring that illustrate the benefits of low-cost country sourcing may no longer outweigh a number of factors. Many of the extreme cost savings in labor from offshoring 5 to 10 years ago have decreased over time and are less compelling. Other cost considerations and quality control issues are bringing operations—and in some cases, management—to the United States. Dissatisfaction with supply chain disruption, product quality, and freight expense increases are forcing companies to consider nearshoring or onshoring all or part of their businesses.

When it comes to speed, agility, and quality, if a company can price its products accordingly, it should keep its operation close to its customers. So some companies are bringing production back to the United States to serve their large customer base. Although large global companies such as Caterpillar and GE have been bringing back operations to the United States, middle-market companies are just beginning to follow suit.

Since it makes good business sense to bring certain types of products—such as highly engineered, custom products requiring complex machinery to run—back to the United States, this trend is expected to continue.

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